Many people think of “retirement savings” and “life insurance” as two completely separate things – but that’s probably because they’ve never heard of a financial strategy called a life insurance retirement plan. Abbreviated “LIRP,” a life insurance retirement plan can offer a solid combination of benefits: secure savings plus the protection for your loved ones that insurance brings. What’s more, a LIRP has added features that just may surprise you.
We found this 2023 article about life insurance retirement plans on the Forbes website. In the article, reporter Cassidy Horton explains some of the basic elements of a LIRP and offers a helpful list of pros and cons. As she points out, this type of plan offers the benefits of life insurance plus the security of retirement savings. “A LIRP won’t fully replace your IRA or 401(k),” the advises, “but it can be used as a supplement to your current retirement planning strategy.”
The Basics: A Life Insurance Retirement Plan Defined
Horton begins her Forbes article with a simple explanation. “A life insurance retirement plan is a permanent life insurance policy, such as universal life insurance, that combines life insurance coverage with a ‘cash value’ component that you can dip into for retirement money (or anything else you like),” she writes. As you might imagine, a LIRP can’t be built around term life insurance because these policies generate little or no cash value.
Proponents of life insurance retirement plans point to a huge benefit in the form of significant tax advantages. “The cash value grows tax-deferred,” Horton writes, “so you don’t owe taxes on any gains until you withdraw them. Additionally, some policy loans and withdrawals may be tax-free as long as they don’t exceed the amount of money you’ve paid in premiums.”
How Does a Life Insurance Retirement Plan Work?
“With a LIRP,” says Horton, “you pay premiums into a life insurance policy, which builds up cash value over time. The cash value can be withdrawn or borrowed against.” There are a few stipulations, she adds, depending on how old you are when you tap into the policy’s value.
Before age 59½, you can make withdrawals and take out loans tax-free so long as the amount you take out is less than the “basis,” which is the sum of premiums you have paid.
After age 59½, all withdrawals and loans are tax-free.
As with other types of life insurance, your beneficiaries will receive a tax-free death benefit when you pass away. However, that death benefit will be reduced by the amount of any withdrawals you took and policy loans that weren’t paid back. “However,” Horton points out, “if your primary goal with a LIRP is to use the cash value, you may not be concerned about the death benefit amount.”
The Forbes article calls LIRPs “overfunded” insurance policies: you are generally paying in more money than is required to maintain the death benefit. “This excess allows the policy to accumulate cash value more quickly,” the article states, “which can increase the tax-free income stream available during retirement.”
LIRP Loans Versus Withdrawals
The Forbes article refers to the ability to borrow against cash value as “a key benefit” of a life insurance retirement plan. “As your policy’s cash value grows, you can borrow from it to supplement your retirement income—even before age 59½,” Horton writes.
Horton’s article describes the borrowing process as pretty simple. Decide how much you want to take out based on your policy’s cash value. Follow your insurance company procedures to ask for the loan and you’ll have it quickly. Best of all, repayment is flexible, says Forbes.
“There’s no strict repayment schedule, so you can repay the loan at your convenience,” the article explains. Still, it’s important to manage any loans carefully, because unpaid loans reduce your death benefit. You’ll also keep on paying premiums, and if those premiums are less than the amount required to maintain cash value at the required level, your policy can lapse. If you mismanage your LIRP loans, you could get socked with higher premiums to keep the policy in force.
Withdrawals are even simpler, says Horton. “Before you turn 59½, you can withdraw money tax-free up to the basis. Withdrawal amounts above the basis are taxable. After age 59½, withdrawals are not taxable.”
Pros and Cons of a LIRP
As we’ve noted, a LIRP can be a useful tool for retirement planning, “but,” Horton advises, “it’s important to carefully consider the pros and cons before making a decision.” Here’s her list:
LIRP pros:
*Tax-free income in retirement
*Tax-free death benefit for beneficiaries
*No contribution limits
*No required minimum distributions (RMDs)
*Guaranteed return rates on cash value with some policies
LIRP cons:
*Higher premiums and fees
*Not a standalone retirement solution
*Withdrawals and unpaid loans reduce the death benefit
*Potential for policy lapse if cash value drops below a certain minimum
*Substantial amount of cash value needed to generate tax-free income
What’s the Cost of a Life Insurance Retirement Plan?
As with any form of investment, a life insurance retirement plan comes with costs and fees. These will generally include:
Premiums: The amount depends on your age, your health, and the level of coverage and other factors. The younger and healthier you are, the lower your life insurance quotes.
Fees: “There will be charges associated with your LIRP,” says Horton, “including administrative fees, expense fees and surrender charges.” Check your insurance policy illustration carefully.
Riders: You may be able to add coverage such as long-term care or disability income to your policy. The premium surcharges for these added benefits are referred to as riders.
Taxes: If you surrender your policy or take out too much, your taxes could be affected. Make sure you ask the right questions first.
Life Insurance Retirement Plans vs. 401(k)s and IRAs
The Forbes article lists several points of difference between LIRPs and commonly known retirement tools such as 401(k)s and IRAs. Many retirees choose to use a LIRP in conjunction with one of these retirement plans since the plans work differently.
LIRP vs. 401(k)s: The most obvious difference is that a 401(k) is employer-sponsored while your LIRP is your own, individually managed by you. Most 401(k) plans – and the similar 403(b) plans for non-profits and other qualifying employers – provide the ability to boost your retirement savings through some form of employer contribution. There’s an IRS limit to the amount you can save in a 401(k), but not for a life insurance retirement plan.
LIRP vs. IRAs: While your LIRP provides both life insurance benefits and cash value growth, your individual retirement account is purely for investment. When it comes to tax advantages, LIRPs are more like Roth IRAs in that you don’t pay taxes on withdrawals after you hit age 59½. IRAs have annual contribution limits, but LIRPs do not. One major difference, says Forbes, is the IRS requirement for RMDs, or required minimum distribution, from your non-Roth IRA – a stipulation that doesn’t apply to your LIRP. “You can keep funds invested in a LIRP as long as you wish,” Horton writes.
Who Needs a Life Insurance Retirement Plan?
Horton ends her article with simple statement of need. “A life insurance retirement plan may make sense,” she suggests, “if any of these situations apply to you.” Here’s her list:
You’ve maxed out your other retirement accounts. If you hit your limits on 401(k) and IRA contributions, a LIRP could be a way to save more for retirement.
You have a high net worth. The death benefit from your policy can be used to pay estate taxes, so your heirs may not have to sell assets to cover the tax bill.
You want to diversify your retirement portfolio. Depending on the life insurance policy type, the cash value of a LIRP can be invested in a variety of asset classes, including stocks, bonds and mutual funds.
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(originally reported at www.forbes.com)